|
|
Archived
Tax Columns
Click on the headline to view article.
|
Moncton Times & Transcript ~ Tax Help Plus ~ Income Trusts ~ November 7, 2006 - 29 Nov 2006 by TaxHelp
|
What a difference a week makes! Even though the relatively new federal Conservatives expressly stated that they would not impact the tax rules surrounding income trusts, last week Finance Minister Jim Flaherty announced changes that would effectively negate the benefit throwing some confusion into the market. While there have been all kinds of reports of extreme paper losses to investment portfolios, a rational approach and time should allow the values to settle.
Probably the reason the government ended up acting directly ties to the popularity of income trusts. Of course, here in the province we are old hands having experienced the Aliant corporate conversion this past summer into the Bell Aliant Regional Communications Income Fund. As a matter of fact, it just finished its inaugural quarter a couple of weeks back establishing a projected annualized payout rate in excess of 8 per cent.
Back at the turn of the millennium which is not as long ago as it sounds, income trusts represented about $20 billion as an investment segment. Today that number is closer to $200 billion. And another couple of large telecoms were planning their conversions – Bell’s parent BCE at the end of the year and Telus early next year. So what was the attraction toward the downstream change?
Why do you buy RRSPs? Sure it’s because you’re going to retire someday – but c’mon, admit it – it’s really about lowering your tax bill today, isn’t it? The people in charge of steering these large corporations form income trusts so that they can avoid taxes. This generates a resultant jump in the stock price, thereby making their shareholders happy (and perhaps guaranteeing themselves an even larger bonus).
Since the consensus was that the market would continue to grow with various sources reporting that the market would expand to $250 billion over the next year, it’s probably important to recognize that the big finance guys are going to keep doing these deals. And while Ottawa was forced to act in this area again, you may be interested in how they worked so you can be armed around the water cooler.
In general, income from a trust is taxed in the hands of the beneficiary or in this case the unitholder (which is the trust equivalent of the shareholder). Conversely, corporations are taxed on their profits. People with trust income pay tax on those funds at their marginal tax rate. People with shares in corporations pay tax on the income they receive (known as dividends) at their marginal rate as well. The challenge is to find a way to not have the effect of double taxation - a corporate tax and a personal tax, thereby making the underlying company more attractive to investors. Hence the popularity of income trusts. The active company creates a line item expense – royalty payments for instance – and this expense represents the profit. This royalty payment is paid to the income trust, and is a write-off (just like you write-off your RRSP contribution) thereby reducing the taxable profit at the bottom line to a negligible amount and avoiding the tax bill. It’s been suggested that the BCE change was going to allow the company to avoid $250 million in taxes next year alone.
At any rate, the trust pays the income out to the unitholder, where it is taxed in his or her hands. In light of the income trusts, Ottawa changed the way the dividend tax credit mechanism works when an individual files a tax return to make the corporation an equally attractive investment. It increased the gross-up value on dividends to 45 per cent and increased the credit to about 19 per cent. Someone who has the lowest marginal rate of 15.25 per cent this year will see their qualified dividends attract virtually no tax federally.
The changes announced by Ottawa last week will be applied to existing trusts starting in the year 2011 and will be effective immediately for any new trusts trading after the start of November 1, 2006. While this severely crimps those who were specifically looking to avoid tax, there will still be businesses that form income trusts because they make sense. As a result, anyone who holds shares in a company that becomes an income trust may have to deal with a capital gains issue. When the shares are swapped for income trust units, even though the investor does not receive any funds the exchange is treated as a disposition. This can result in capital gains. The taxable income is calculated based on the swapped price less the cost of the share divided by two. Put another way, if someone had bought ABC Co for $10 and it is $20 on the day of the change, the profit (in this case known as a capital gain, and ignoring any sales commissions) is $10 and the taxpayer must report $5 on his tax return.
While business will lobby for exemptions to the new rules, it will be interesting to see how this area plays out over the next few months.
Roger Haineault is with Help 4 Taxes. His column "Tax Help Plus ..." appears each Tuesday. For questions, comments or column suggestions he can be reached by calling 855-HELP (4357) or by emailing roger@help4taxes.ca
|
|
|
|
|
